The effect of external shocks on macroeconomic performance and monetary policy in a small open economy: Evidence from Zambia

Abstract

This study investigates the impact of external shocks on domestic macroeconomic variables and monetary policy of a small open economy, Zambia using a structural VAR estimated with quarterly data covering the period Q1 2000 to Q1 2016. Results indicate that monetary policy is pro-cyclical in response to external shocks, while the dominant external shocks are commodity price shocks followed by financial shocks. This implies that external shocks are clear determinants of monetary policy direction in Zambia owing to their effect on key macroeconomic variable. In addition, results from impulse responses indicate that external shocks have significant effects on Zambia's macroeconomic performance. Specifically, commodity price shocks have significant effects on output and exchange rate while financial shocks have significant effects on prices and exchange rate.